“At Par”: Understanding Bond Valuation
Bond pricing differs greatly from stock valuation. Debt instruments are issued in denominations of $100, $1,000, or $5,000, which is considered their par value. When trading, the market price of a bond can be above, below or at par depending on market forces.
- The term “at par” means face value or nominal value, meaning the original price of a security at issuance.
- Par values are static, as opposed to market prices which fluctuate based on market forces including prevailing interest rates, credit ratings and time to maturity.
- Investors in debt securities receive the bond’s par value at its maturity date.
What Does “at Par” Mean?
Also known as nominal value, par value refers to the face value of a bond at issuance or the stock value stated in the corporate charter.
Financial instruments, namely debt instruments, can trade at par, above par, or below par.
Par value differs from the market value which fluctuates for bonds based on market interest rates, time to maturity date, company news and credit ratings. Both par value and the bond’s coupon rate remain the same for the entire life of the bond.
Understanding Par Value
Par value is important for fixed income instruments because it is used to determine the dollar amount of coupon payments. The market price of a bond is rarely at par due to constant market fluctuations.
Corporate bonds are typically issued at $1,000 or $100 while municipal bonds typically have par values of $5,000. Treasury Bills are typically issued at $100 par value.
When trading, bond values are described as percentages of 100, meaning a bond trading at par would be quoted at 100. A quote of 90 would mean the market price of the bond is 90% of its par value.
In the case of equities, the par value has very little relation to the shares’ market price. Instead, it refers to the original share price, or the stock value declared in the corporate charter.
Par Value of Bonds
Bonds are debt instruments, meaning bond issuers promise to repay bondholders a certain amount of money at a determined maturity date. During the life of the bond, investors also receive coupon payments. The amount of money paid to bondholders at maturity is the bond’s par value.
While par value refers to the face value of the bond, not all bonds are issued at their par value. Discount bonds are issued below par while other bonds can be issued at a premium, meaning they are issued above par value.
The price of a bond at issuance depends on the prevailing interest rate. For example, during periods of low interest rates, more bonds tend to trade above par, or at a premium. The opposite is true when interest rates are climbing: more bonds tend to trade at a discount.
At the bond’s maturity date, every bondholder will receive the par value, regardless of if they purchased it at a discount or premium.
Why Would an Investor Purchase a Bond at a Premium?
Bonds trade at premiums when its stated interest rate is greater than the market rate (and therefore the bond’s coupon rate).
An investor may choose to purchase a bond issued previously when interest rates were higher to secure greater returns from the bond’s coupon payments, compared to bonds issued at the lower prevailing rate.
Coupon Rates of Bonds
The coupon rate of a bond is the amount of money bondholders will earn as compensation through interest payments. This is the cash flow of the bond.
For example, a bond with a par value of $1,000 and a coupon rate of 5% will have annual coupon payments of 5% x $1,000 = $50.
Interest rates and coupon rates determine whether a bond is trading above, at, or below par.
For example, if a 3% coupon bond is issued when interest rates are 3%, the bond will trade at par value. However, if interest rates fall to 2%, the value of the bond will rise, causing it to trade at a premium because the bond will be more attractive than bonds issued with a 2% coupon rate.
Why Par Value Matters for Bond Investors
Par value is crucial in understanding bond valuation and fixed income trading because regardless of the price paid to own a bond, issuers pay back only the par value, also known as the principal investment.
The difference between market value and par value means that individual bonds may be more profitable than others based on more than just their coupon rate.
Bond investors typically calculate a few different rates of returns to compare individual bonds. Yield-to-maturity (YTM), yield-to-call (YTC) and yield-to-worst (YTW) are all calculations to help bond investors determine the rate of return they’d earn from holding the bond.
YTM is most common, it accounts for the market value of the bond and the present value of the bond’s future interest payments. YTC makes the assumption that the bond will be called before its maturity date, therefore changing the cash flow from interest payments. YTW is used when a bond has multiple options — either to be held to maturity or held until called by the issuer — and uses the lower of the two options.
These rates are often presented as a percentage. For example, if a bond’s YTM is 10%, an investor can expect a 10% rate of return on the bond when considering both the principal payment and annual coupon payments.
Investors shouldn’t worry about the exact steps to calculate YTM, there are numerous online calculators as well as excel functions that can do the work for you.
Par Value of Stocks
While par value is most commonly used to discuss bonds, many stocks also have par value. However, because equity instruments have different payment structures, the par value of stocks doesn’t refer to the face value and instead refers to the price floor of how low a company can sell its stock.
Certain state regulators require companies to issue stock with a minimum par value. Because par value doesn’t impact market value of stocks, it is acting solely as a regulatory requirement.
Par Value for Common Stock
Because of state regulation requirements, most common stock is issued with a par value, but it means essentially nothing for investors. In fact, most stock investors won’t even be aware of a stock’s par value as it has no impact on the stock’s market value.
Par values of common stock tend to be priced extremely low, for example, the par value for shares of Apple (AAPL) is $0.0001. Of course, Apple shares have never traded anywhere near that value, but this ensures that Apple cannot sell shares for less than $0.0001.
Some states do not require par value for stocks, so not every common stock is going to have a par value. For stocks that do have a par value, it is declared on the company’s corporate charter as well as the Shareholders’ Equity portion of the company’s balance sheet.
Par Value for Preferred Stock
Preferred stock represents equity in a company, the same way common stock does, but it also guarantees a fixed dividend payment, similar to bond’s coupon payments.
Par value for preferred stock is used to determine the dividend paid to investors. Like bonds, dividends are stated as percentages and are also commonly referred to as a coupon rate. That rate is multiplied by the face value to calculate the dividend.
The Bottom Line
Par value is useful for investors because it works as a benchmark for pricing bonds. The present value of a bond can be above, below or at par value based on interest rates, credit ratings and additional market forces.